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Executive Summary

The Senate Finance
Committee recently passed, by a vote of 16 to 5, the Prescription
Drug and Medicare Improvement Act of 2003. The unnumbered bill is
scheduled for Senate floor consideration starting
immediately.

The Senate bill's
provisions cover the creation of a universal Medicare Prescription
Drug Program under a new Part D (Title I); the replacement of the
Medicare+Choice (Part C) program with a new Medicare Advantage
program under Part C (Title II); the creation of a Center for
Medicare Choice (Title III) that would administer Part C and Part D
of the Medicare program; the addition of miscellaneous amendments
to the existing Medicare fee-for-service program, including
reimbursement updates for medical facilities in rural areas (Title
IV); and several provisions for Medicare regulatory relief (Title
VI).

This analysis is
based on a descriptive outline of the Senate bill's provisions; it
is not based on formal legislative language, which has been
unavailable to the public.[1]
This analysis focuses only on the provisions of Title I, Title II,
and Title III. The analysis also does not reflect Senate Finance
Committee amendments to the draft outline, including the changes in
the out-of-pocket limits on the standardized drug benefit. (The
Committee revised the drug benefit slightly: it will retain the
originally proposed $35 per month premium, the $275 deductible, but
it will extend the payment of 50 percent of the drug costs up to an
annual amount $4500. At a total cost of $5813 in drug expenses, the
government would assume 90 percent of the costs of the
benefit.)

The New Medicare
Drug Benefit.The basic
structure of the drug benefit is traditional Medicare: cost-plus
payments to private drug plans - exactly the way Medicare
started out paying doctors and hospitals in 1965. While, in
theory, there will be "risk-bearing" drug plans, assuming that
plans come forward and participate, the actual share of the risk
that they will bear will be limited if not marginal. In fact, their
risk exposure will be more like that of a hospital's risk exposure
with respect to Medicare payments for DSH and DRG outliers, than
the risk exposure of a true insurance plan.

As a rough
estimate, the "risk-bearing" plans (drug only and Medicare
Advantage) would be liable for, net, no more than about 20 percent
of the total risk (combined price and volume risk) of the benefits
they cover.

The Senate Finance
bill also creates "fallback" plans. The proposed "fallback" plans
would not be risk-bearing entities (pure cost-plus financing) and
thus Medicare (the taxpayers) would bear the full, combined price
and volume risks for those enrollees.

The "fallback"
plans will be pharmacy benefit managers (PBMs) functioning as
"fiscal intermediaries" with the added twist that they have the
power to negotiate prices and restrict access. This raises an
obvious concern. It will likely not be long before this flexibility
for the PBMs is replaced with uniform price schedules and coverage
rules. Also, it is not clear from the legislative text why any PBM
would become a "risk-bearing" plan.

Nowhere is the word
"profit" mentioned in Title I, while distinctions between claims
costs and administrative costs appear throughout the program
design. By inference, any profit will consist of a couple of
percentage points in the plans' administrative cost allowance. Even
drug plans that are successful in keeping actual claims costs below
projected claims cost will not see those savings as profit. First,
standard prudent insurance practice is to retain them as reserves
against possible spikes in future claims. Second, they will have to
share those savings with Medicare. Third, in the first five years,
Medicare will escrow any savings above 3 percent in a
"stabilization reserve fund" which will be in addition to the
normal reserve funds the plans are expected to keep on their own.
Thus, profits for both risk bearing and non-risk-bearing plans must
come from the administrative cost allowances they negotiate with
Medicare. This is basically cost-plus financing.

Separate Drug Payments and "Risk
Corridors." Also, the new Medicare Advantage plans (created
under Title II) will be paid separately, and be required to do
detailed separate accounting so that the government officials can
adjust their payments for the drug component of their comprehensive
coverage. In the case of those plans, this will exacerbate the very
problem that the original premium support approach (for example:
the 1999 Breaux-Thomas proposal and its various successors) was
designed to correct - the component management and line item
reimbursement that generates fragmented, episodic care.

Particularly
troublesome are the provisions in the "risk corridor" and
"reinsurance" sections designed to recapture payments when a
plan "overpays," relative to the national average price negotiated
by all plans, for a specific drug. This provision will likely keep
out-or force out-drug plans that don't think they have enough
market share to get the best deal among all the plans nationally
(not just the ones they compete against in their chosen area). It
will also induce uniform pricing by manufactures-no more
competition for discounts.

Finally, to
administer the "overpayment recapture" provisions, Medicare will
need to collect all the price and volume data from all the plans
for each and every drug, for each and every prescription, and for
each and every beneficiary. This provision contains its own
political dynamics: it is inevitable that Medicare officials or
members of Congress will aggregate that data, and develop a list of
how much Medicare spends in total on each specific prescription
drug. This will inevitably lead to congressional hearings targeting
the high cost/high volume drugs that are costing Medicare the most
money. These political pressures will in turn trigger demands for
the inevitable "cost containment" (price and access control)
legislation.

In summary, Title I
creates a new Medicare drug program, delivered through private
drug-only plans, in which the taxpayers will be liable for more
than 80 percent of the total risk of the total drug benefit. The
fiscal pressures are likely to trigger demands for price and access
controls to control costs. Meanwhile, the structure of the benefit
is such that its incentives actually work against integrating drug
coverage into the kind of coordinated, chronic-care delivery model
that most health policy experts view as the essential reform needed
to improve medical care for senior citizens.

The Medicare
Advantage System.Title II of
the bill creates a new system of health plans, replacing the flawed
"Medicare+Choice" experiment with the new " Medicare Advantage"
program. Title III creates the Center for Medicare
Choice.

In some respects,
these titles may be intended to resemble the popular and successful
Federal Employees Health Benefits Program (FEHBP). Medicare
Advantage is a system of competing private plans; government
payment is made to these plans on behalf of the Medicare
beneficiary; and an Administrator who will negotiate and enforce
contracts with private plans administers the program.

In crucial respects, however, this proposed
program does not resemble the FEHBP. In the FEHBP, there is no
government-standardized drug benefit or system of drug-only plans,
like there is proposed in the Senate bill. In the Senate bill,
there is a strongly enforced comprehensive standardization of
benefits, including drug coverage, which is not found in the FEHBP.
The formula for payment to private plans in Medicare Advantage is
based largely on Medicare's system of administered pricing, while
in the FEHBP the government payment is based on the weighted
average premiums of plans in a real competitive market. In Medicare
advantage, the government limits the number of Preferred Provider
Organizations (PPOs) that may compete in any given region of the
country to three, while in the FEHBP there is no such limit.

Perhaps the most
important difference between the program developed in the Senate
draft and the FEHBP is likely to be the governance of the
program, specifically the breadth and reach of government
regulation. The statutory language that governs the FEHBP, a
program that covers roughly nine million federal workers and
retirees and their dependents, is a little more than 40 pages long.
The administration of the program is decentralized; it is largely
undertaken by the private health plans themselves under Office of
Personnel Management (OPM) oversight. Most of the heavy lifting in
the program is accomplished through the free market forces of
consumer choice and competition. That is why it has been a success,
in sharp contrast to the Medicare+Choice program, which has been a
regulatory nightmare.

In Medicare Advantage, the intricacy of the
statutory provisions, and the breadth of regulatory authority given
to the Administrator of the Center for Medicare Choice, is very
broad and potentially very deep, while in the FEHBP, OPM's
statutory language is comparatively sparse and its specific mission
in regulation is to carry out the limited responsibilities
entrusted to it in Chapter 89 of Title V and, in regard to health
plans specifically, to set "reasonable minimum standards" for
health plan participation. That is what OPM does. There are less
than 100 pages in the Code of Federal Regulations governing the
FEHBP.

In the Medicare
Advantage system, the relationship between the Administrator and
private plans is likely to be a regulatory relationship,
similar to that found in the flawed "Medicare+Choice" program; in
the FEHBP, the relationship between OPM and private plans is, and
throughout its 43-year history generally has been, a business
relationship. It has been historically a successful and
fruitful one, yielding high quality of care and a high degree of
satisfaction for millions of federal workers and retirees and their
families, including many retired federal workers who are not
covered by Medicare and thus get all of their health care benefits
through FEHBP.

TITLE I - THE DRUG BENEFIT

Part I - Basic drug benefit structure

Section 1860D6:The Standard Coverage
Requirement. The standard coverage has a "doughnut hole."
However, entities could offer plans with more generous coverage,
provided they also offered the standard coverage package. They
could also offer actuarially equivalent plans with different cost
sharing. But to do so,"the actuarial value of total coverage
would have to be at least equal to the actuarial value of standard
coverage. The unsubsidized value of coverage would have to be at
least equal to the unsubsidized value of standard coverage.
Further, the coverage would be designed, based on a representative
pattern of utilization, to cover the same percentage of costs up to
the initial benefit limit as provided under the standard plan. The
limitation on out-of-pocket expenditures would be the same as under
standard coverage. The entity would have to apply for and receive
approval from the Administrator for an alternative benefit
design."

Analysis: This is an overly
prescriptive approach. It makes it less likely that the proposed
entities will seek to offer actuarially equivalent coverage.

Section 1860-D-6:Coverage Breakpoints.
The coverage breakpoints ($276 deductible, $3,450 initial coverage
limit, $3,700 in out-of-pocket costs triggering 90 percent
coverage) would be indexed, "in future years by the percentage
increase in average per capita expenditures for covered drugs for
the year ending the previous July."

Analysis: This is a reasonable
benchmark to use for indexing and to restrain growth in program
expenditure, if one assumes that one should index these elements
uniformly.

Section 1860D:Covered Drugs. Covered
drugs would be all drugs, biologics and insulin covered under
Medicaid, except for smoking cessation agents and drugs covered
under Medicare Parts A&B, plus vaccines licensed under Section
351 of the PHSA. (1860D - Definitions) Drugs covered by Medicare
Parts A&B would still be paid for by those parts of the
program.

Analysis: This appears to be a
reasonable definition of "covered drugs." For the future, it may
not be prudent for Congress to limit its definition of "covered"
drugs to the current statutory definitions.

Section 1860D:Medical Necessity. Also,
"coverage would be extended to any use of a covered drug for a
medically accepted indication." Individual plans could exclude
drugs as part of their formularies or on grounds that their use did
not meet Medicare's definition of "reasonable and necessary."

Analysis: This appears to mean
coverage would extend to generally accepted off-label uses, which
is consistent with private practice.

Section 1860D-6: Best Price
Exclusion. "The bill would exempt any prices negotiated by a
Medicare Prescription Drug plan, Medicare Advantage plan, or
qualified retiree program from Medicaid's determination of "best
price" for purposes of the Medicaid drug rebate program."

Analysis: This is a sound
provision, since it allows manufacturers to offer discounts in this
market without fear that they will trigger larger Medicaid
rebates.

Section 1860D-2: Beneficiary Choice of
Coverage. Beneficiaries choose coverage when they become
Medicare eligible, or later if they initially choose to retain
other, equivalent coverage through a private retiree coverage plan,
Medicaid, a state pharmacy assistance program or VA, and their
coverage is then either discontinued or scaled back to be less than
the "standard" coverage in Part D. Enrollment is similar to that of
Part B with penalties for late enrollment. Once initially enrolled,
beneficiaries would be able choose coverage annually.

Effective Date of the Part D Drug
Program. The new Part D drug program would go into effect
January 1, 2006. Between January 1, 2004, and June 30, 2006, the
Centers for Medicare and Medicaid Services (CMS) would operate a
"transitional" prescription drug discount card program for Medicare
beneficiaries. (The program is essentially what the Administration
attempted to do last year without legislation.) In addition, the
cards would be accompanied by $600 per year in subsidies for
beneficiaries "meeting the definition of QMB, SLMB, or QI-1, who
were not eligible to receive drug benefits under Medicaid. …
Beneficiaries would be subject to cost-sharing requirements which
could not be less than 10% of the negotiated price for a drug.
Cost-sharing charges would not count against the $150 available per
calendar quarter. The Secretary would establish procedures whereby
spouses, both of whom were enrolled in drug assistance card
programs, could use the benefits on the other spouse's card. At a
minimum, card sponsors would provide low-income enrollees with a
minimum of a 20% discount from the average wholesale price for each
covered drug." (Sec. 1807A)

Analysis: The card program and
subsidies would be eliminated 6 months after the new Part D
coverage took effect. This is odd, since the drug card and the
subsidies for low-income beneficiaries is one of the most
reasonable features of the legislation. Instead of sun-setting this
provision, it should be retained as the "fallback" alternative in
areas where seniors lack the option of choosing from competing
drugs plans.

Part II - The
Selection of Drug Plans

Section 1860D-6: The Process of Selecting a
Drug Plan for Participation. The new Center for Medicare
Choices (CMC), created under Title II, would divide the country
into at least 10 "service areas" in which plans will be offered.
(1860D-10)

Entities can offer plans with either the
"standard coverage" cost-sharing structure, with a more generous
cost-sharing structure, or with a cost-sharing structure that is
different from, but actuarially equivalent to, the standard
coverage cost-sharing structure. The standard cost-sharing
structure and any actuarially equivalent cost-sharing structures
are termed "qualified coverage." (1860D-6)

Plans seeking to participate would need to be
licensed as risk-bearing entities in the states in which they will
offer coverage, or have that requirement waived by CMC, and meet a
variety of operational standards with respect to issues such as:
solvency, reserve requirements, pharmacy network adequacy,
out-of-network pharmacy access, the use and structure of
formularies, the makeup and decision-making processes of the
pharmaceutical and therapeutic (P&T) committees that create
formularies, programs for drug utilization management and
medication therapy management, consumer information, beneficiary
appeals processes, privacy of medical records, etc. (1860D-4, 5,
7)

Plans seeking to participate must also submit
bids to CMC. (1860D-12) The bids must include:

A description of the plan benefits;

The actuarial value of the "qualified
coverage" portion of the plan benefits;

The service area in which the plan will be
offered (could be one of the CMC defined service areas or could be
nationwide, and plans can submit separate bids for each of several
different service areas);

The monthly premium, subdivided according to
the portions that constitute:

The standard coverage or an
actuarial equivalent

Benefits in excess of the standard
coverage

Premium reductions attributable to
reinsurance payments to the plan from CMC (does not specify whether
prospective or retrospective, but is presumably retrospective like
DSH and DRG outliers);

Any plan to use funds available to the
entity in the "stabilization reserve fund" to reduce enrollee
premiums.

CMC reviews bids and, for both the standard
coverage and additional coverage, is required to apply the FEHBP
standard (embodied in Section 8902 of Chapter 89 of Title V) that
each bid, "reasonably and equitably reflects the cost of the
benefits provided."(1860D-13) CMC would have authority to
negotiate terms, conditions, and premiums and would need to be
satisfied that the plan design "would not result in favorable
selection of beneficiaries." Then CMC approves or rejects each
bid.

Analysis: There is no limit on
how many drug plans CMC can approve to be offered in any service
area, nor is there any provision that if a plan meets a specific
set of requirements CMC must automatically approve it. Thus, CMC
seems to have considerable discretionary authority in approving
plans, since it could cite failure to meet any one of the foregoing
provisions (most of which are at least partly subjective) as a
reason to reject a plan. (1860D-13)

Part III - How Medicare Will
Pay Private Drug Plans

Section 1860D-14: Payment of Private Drug
Plans. All of the payment provisions outlined below would apply
to both drug-only plans and to the drug portion of
the newly proposed Medicare Advantage plans. The process is as
follows:

CMC computes the premium amount for the
qualified coverage portion (i.e., standard coverage or an
actuarially equivalent alternative) of each private plan (both drug
only and Medicare Advantage). (1860D-14)

CMC computes a monthly national weighted
average premium for the standard coverage. The weighting is based
on the previous year's enrollment in the various drug-only and
Medicare Advantage plans. (1860D-15)

CMC creates a budget neutral, geographic
risk adjustor for plan payments to "account for differences in
prescription drug prices across service areas."
(1860D-16)

CMC creates a budget neutral, actuarial risk
adjustor for plan payments to account for "variations in costs
based on the differences in actuarial risk of different enrollees
being served." (1860D-11)

The risk-adjusted plan payments would then
be further adjusted up or down, retrospectively, based on how
actual claims costs compared to projected claims costs using a
"risk corridor" mechanism. (1860D-16)

Each year CMC would establish a prospective
"target" payment amount for each plan, "defined as the total of
plan premiums minus a percentage (negotiated between the
Administrator and the entity) for administrative costs."
(1860D-16) Thus, the "target" payment amount equals the anticipated
total claims costs for each plan.

CMC applies a set of "risk corridors" to
each plan's "target" amount. (1860D-16) The risk corridors are
narrower in the first years, expanding to thresholds of +/- 5% and
+/- 10% from 2011 onward. Thus, from 2011 onward, if a plan's
actual claims costs were:

Between 95% and 105% of the prospective
"target" the plan would either keep the savings or absorb the
loss.

Between 105% and 110% of the target, CMC
would pay a percentage of the additional costs.

Above 110% of the target, CMC would pay an
even larger percentage of the additional costs.

Between 90% and 95% of the target, the plan
would have to pay back to CMC a portion of the savings.

Below 90% of the target, the plan would have
to pay back to CMC a different portion of the savings.

However, before calculating the payment
effects of the risk corridor provisions for any given plan, CMC
would first make yet another adjustment. CMC would adjust the
plan's reported claims costs, "in cases where the actual costs
for a covered drug exceeded the average negotiated price for such
drug in the year." (1860D-6) Thus, individual plans would be
penalized for "over-paying" for specific drugs relative to the
national average price paid for the drug by all plans.

CMC would also compensate plans with
reinsurance payments for individual high-cost beneficiaries,
defined as those whose drug spending exceeded the out-of-pocket
limit. Payments would equal 80 percent of the expenses above the
beneficiary's out-of-pocket limit, after reducing the plans actual
costs by the amount (if any) that the plan "overpaid" for specific
drugs for the specific beneficiary. (1860D-20) Thus, individual
plans would be penalized for "over-paying" for specific drugs for
specific, high-cost beneficiaries, relative to the national average
price paid for the drug by all plans for all beneficiaries.

For the first five years of the program
(2006-2010), CMC would create and operate a "stabilization reserve
fund." Any savings of 3 percent or more in actual claims costs
relative to the plan's target would be kept by CMC and placed in a
"stabilization reserve fund" account for the plan. Then, starting
in 2008, the plan could draw down any savings it had accrued to
offset increases in the plan's actual costs for the years
2008-2010, and thus "stabilize" the plan's premiums for those
years. The accounts would terminate after five years.
(1860D-16)

Analysis: The provisions for
recapturing "overpayments" for specific drugs in the calculation of
risk corridor and reinsurance payments would have a number of
effects, as can be seen from the following hypothetical
example:

A drug plan has an anticipated claims cost
target of $1,000,000, but actual claims costs come in at
$1,060,000. In theory the plan would have to eat $50,000 of its
$60,000 loss, since that is within the +/-5 percent risk corridor,
and CMC would pay part (50 percent in this example) of the
remaining $10,000 of the loss. Thus total CMC payments would be
$1,005,000 and the plan's net loss would be $55,000.

But in reviewing the prices paid and the
volume purchased for each drug by the plan, CMC determines that the
plan paid a total of $10,000 for drug X at $100 per scrip while the
national average paid for drug X was $90 per scrip. Thus, CMC
concludes that the plan "overpaid" for drug X by $1,000. So, CMC
then takes the plan's $1,060,000 actual claims cost and
reduces it to $1,059,000. Now the plan has only $9,000 of
excess claims eligible for the 50% reimbursement by CMC, for a
reimbursement of $4,500, not $5,000. Thus the plan has been
penalized another $500 for "over-paying" on Drug X and its actual
net loss is $55,500.

The effect is to impose a 5 percent
"overpayment penalty" on the plan for not negotiating a low enough
price for drug X. Of course, the more generous CMC is in
reimbursing the plans (the draft talks in places about 75 percent
or 90 percent compensation for excess costs) the larger the
potential "overpayment penalty" (e.g., 7.5%, 9%). Considering that
this is an example of just one of hundreds of drugs the plan
covers, the implications become clear. CMC can further reduce, or
even eliminate, the rest of the additional $4,500 it in theory owes
the plan to compensate for it's higher than expected losses if it
finds that the plan "overpaid" for other drugs.

This proposed process has certain programmatic
consequences. First, this saves Medicare money. Second, this is a
great way to discipline plans into demanding deeper discounts from
manufacturers and restricting beneficiary access. Third, it drives
small players to either avoid or exit the market if they don't feel
that they can get discounts as deep as their bigger competitors
(and it effectively makes their competition all the plans nationally, not just the ones
they compete against in their chosen area). This is
compounded by the fact that plans get no equivalent, offsetting
reward for negotiating a below average price for other
drugs.

With fewer players in the market, more areas
of the country are left with only a pre-ordained "fallback" drug
plan. Manufacturers have diminished incentives to offer discounts
and are more likely to just charge all plans the same price.
Uniform manufacturer pricing works fine for the remaining "at-risk"
plans, as they just become more like cost-plus claims
administrators - same as the "fallback plans". The "at-risk" plans
would then no longer have a price risk, just a volume risk, and the
"fallback" plans would have neither risk.

The proposed process will not harm
manufacturers -- as long as they retain the freedom to set the
uniform prices that they charge. Of course, since CMC needs all the
price and volume data from all the plans for each and every drug
that they purchase, as well as the patient-specific price and
volume data for each drug consumed by one or more of their
"high-cost" enrollees, it will not take long before CMC aggregates
the data into a list of how much Medicare spends in total on each
specific drug. That will then be followed by the inevitable
hearings targeting the high cost/high volume drugs that are costing
Medicare the most money, which will in turn produce the inevitable
"cost containment" (price and access control) legislation.

Part IV - The Creation of Fallback Plans

Section 1860D-13: The Creation of FallBack
Drug Plans. In any "service area" where there are not at least
two plans with bids acceptable to CMC, then CMC will first try to
induce more plans to bid by reducing the risk borne by plans in
that region by having Medicare pay a greater share of the costs
above the risk corridor thresholds and/or a larger reinsurance
percentage (the standard share is 80 percent for the excess claims
of high risk individuals.) (1860D-13) However, CMC would not be
allowed to offer "full underwriting of financial risk for any
entity and could not provide for the underwriting of any financial
risk for a public entity" (1860D-13)

Analysis: Section
1860D-Definitions allow a state pharmacy assistance program to
apply to be a plan. Presumably, this therefore means that CMC could
not assume the risk for such plans and thus, by definition, they
could not be "fallback" plans. For the other plans, given that CMC
is already bearing the majority of the risk in areas where there is
competition, it is hard to see how letting CMC pick up more of the
risk (between 80% and 99%) would induce more plans to
participate.

Section 1860D-13; Medicare Risk
Assumption. If CMC still cannot get at least two plans, then it
will negotiate a contract with an entity to be the "fallback" plan
and provide the standard coverage on a straight cost-plus basis,
with Medicare bearing all of the risk. There can be only one such
"fallback" plan per service area. (1860D-13)

In cases where there is only one risk-bearing
plan plus the "fallback" plan, beneficiaries who did not elect a
choice would be assigned to the risk-bearing plan and not to the
"fallback" plan. (1860D-13)

Analysis: This levels the
field somewhat since the risk-bearing plan would have an enrollment
advantage to offset the disadvantage that it bears some risk while
the "fallback" bears no risk. Also, "Entities that have
submitted bids to be a qualified risk-bearing entity may not submit
a bid to be a fallback plan." (1860D-13)

The likely effect of this proposed " fallback"
process is that the PBMs will be the "fallback" plan administrators
and/or subcontractors to risk-bearing plans, but will see no
advantage in becoming risk-bearing entities themselves. They are
not risk-bearing entities under their current business models for
the existing non-elderly population, and nothing in this Senate
legislative draft would give them a strong enough incentive to take
on the added burdens of being risk-bearing.

For the "risk-bearing" plans, Medicare would
be assuming roughly +/- 80% of the price/volume risk for the
benefits they cover. For the "fallback" plans Medicare bears all
the price and volume risk with the PBMs acting as Medicare
intermediaries (e.g., cost-plus administrators) with the added
twist that they have the power to negotiate prices and restrict
access. It is hard to imagine that it will take very long before
this flexibility for the PBMs is replaced with uniform price
schedules and coverage rules, since as long as the "fallback" PBMs
retain the ability to negotiate prices and limit access through
formularies, there will be geographic variations among them in both
drug prices and patient access to drugs.

Part V - Beneficiary
payments and subsidies.

Section 1860D-17: The Drug Payment
Process. For each plan, CMC compares the plan's monthly premium
for the "standard" or "qualified" coverage (which excludes the
portion of the premium that is attributable to additional coverage
above the standard level -- e.g., lower deductibles and/or
co-pays), with the national monthly weighted average premium.
(1860D-17) Then:

"If the plan's monthly approved premium
was less than the national average the beneficiary would pay: 1)
25/70 expressed as a percentage of the monthly national average,
minus, 2) the difference between the national average and
the plan's premium." (1860D-17)

"If the plan's monthly premium was
greater than the national average, the beneficiary would pay: 1)
25/70 expressed as a percentage of the monthly national average,
plus 2) the difference between the national average and the
plan's premium." (1860D-17)

Analysis: Basically, the
beneficiary pays 35.7 percent of the national average premium for
the standard coverage, plus or minus the difference between the
national average premium and the premium for the "standard
coverage" portion of the chosen plan.[2]

Section 1860D-18: The Beneficiary Premium
Collection. The beneficiary's share is collected though Social
Security withholding the same as the Part B premium. (1860D-18)
Medicaid dual eligibles would continue to get their drug coverage
through Medicaid. "Persons
meeting the definition of QMB, SLMB, or QI-1, and not eligible for
Medicaid medical and drug benefits, as well as other persons below
160% of the federal poverty level, would receive their drug
benefits through Part D. They would receive assistance for the Part
D premium and cost-sharing charges." (1860D-19)
Subsidies for these beneficiaries take the form of zeroing-out the
deductible, scaling back the cost sharing, paying all of the
premium for beneficiaries with incomes below 135 percent of poverty
and charging sliding scale premiums up to 160 percent of poverty,
at which point the beneficiary is responsible for paying their full
share of the premium. The plans would be reimbursed by CMC for the
difference attributable to the lower cost sharing for these
beneficiaries. (1860D-19)

Analysis:Nowhere does the Senate draft outline
explain how plans that provide coverage that is more generous than
the "standard" coverage collect the additional premium for that
additional coverage from the beneficiary. Presumably, the plans
will bill beneficiaries directly, since there is no provision for
Social Security withholding. Not automating this part of the
premium collection for the plans is a disincentive for them to
provide more generous coverage. In fact, nowhere in the draft does
it actually say that plans either will or will not be able to
charge beneficiaries additional premiums for coverage above the
"standard coverage."

Part V - Employer retiree plans

Section 1860D-21: Payment to Employer Plans
for Drug Coverage. The CMC would pay subsidies to qualified
employer retiree plans for each beneficiary who is eligible for
Part D, but is instead enrolled in the retiree plan. For the
retiree plan to be "qualified" it would have to offer at least the
"standard coverage" or actuarially equivalent coverage. "The
amount of the payment would equal 45/70 expressed as a percentage
of the monthly national average premium for the year, as adjusted
by risk adjusters." (1860D-21) CMC would also compensate
retiree plans with reinsurance payments for individual high-cost
beneficiaries, the same as it would for the Part D plans and the
Medicare Advantage plans, with the same "overpayment" recapture
mechanism. (1860D-20)

Analysis: This provision means
that employer retiree plans would be paid a subsidy equal to 64.3
percent of the national average premium for "standard coverage,"
after adjusting for geographic and actuarial risk differences.[3] To obtain additional,
"reinsurance" payments for their high-cost enrollees, these private
employer plans would have to submit to Medicare data on the prices
they paid for all of the drugs they purchase for their retirees, as
well as patient-specific data on the prices and quantities of
individual drugs consumed by the "high-cost" enrollees for which
they are claiming "reinsurance payments."

TITLE II- THE MEDICARE ADVANTAGE
PROGRAM

Section 201: The Establishment of the
Medicare Advantage System. It would replace Medicare+Choice. It
would include private fee-for-service, PPO plans, PSO, medical
savings accounts (MSAs) or a regional PPO. The statutory
requirements for the plans would remain largely the same,
with "modifications" to reflect the new drug benefit.

Analysis: It appears that
the statutory language that now governs the Medicare+Choice plans
would carry over into the Medicare Advantage program. It is unclear
why the drafters of the Senate bill want to retain residual
language of that statutory framework. The problem, not evident from
the text, is that the statutory provisions of the Medicare+Choice
program were at the heart of many of the well-documented regulatory
difficulties, beyond the administrative payment problems,
encountered by private health plans.[4] Whether the residual
Medicare+ Choice statutory language will continue to contribute to
private plan problems, or whether the Senate language will
alleviate them, remains unclear.

The Senate language, coupled with other
provisions in the draft outline, raises some urgent practical
questions. For example, medical savings accounts are envisioned as
participating in the new Medicare Advantage program. But, as every
student of health policy knows, MSAs are currently subjected to
various federal statutory and regulatory restrictions deliberately
designed to retard their growth in the market. Would the Senate
bill language lift those restrictions for retirees? It is not clear
from the text.

Moreover, with regard to the MSA option, in
particular, it is not clear that active workers would be able to
bring their own MSA plans with them into retirement under the
Medicare Advantage program, or whether they would have to drop
those plans and pick new MSA plans that qualified for participation
under this language. Moreover, it is unclear whether retiring
employees could bring plans with Health Reimbursement Accounts
(HRAs) or other health account options into retirement with them
and qualify under the Medicare Advantage program. In the future,
these plans are certain to garner an ever-larger share of the
non-elderly commercial market. It is not at all clear from the
Senate text that these would qualify. If they do not, the provision
is incompatible with Medicare reform based on consumer choice and
competition.

A far better idea would be to start over and
re-develop the Medicare Advantage program, using the statutory
language of Chapter 89, Title V of the United States Code: the
language that authorizes the Federal Employees Health Benefits
Program (FEHBP). The Senate Finance Committee clearly decided not
to do that, though proponents of the Senate bill make favorable
references to the federal employees model as the basis for their
support of the legislation.

Moreover, to guarantee an open system, it
would be appropriate to include language that provides not only for
PPOs and MSAs, or HMOs or private fee-for-service plans-which may
be overtaken by time and progress in the delivery of health
care-but also to include the broadest possible language that would
include "other private plans or options or health care delivery
programs." Senate bill drafters do not, and cannot, know what the
future may bring; and it is imprudent to lock health care models in
statutory concrete, as they may quickly be overtaken by rapid
changes in the broader health care economy. Such rigidity in
Medicare's original benefit design is precisely the reason that
prescription drug coverage and the need for Medicare reform are
issues today.

Section 201: The Provision Of
Information. The Secretary of HHS would be required to
disseminate nine categories of information about the plans, ranging
from benefits and premiums to drug coverage.

Analysis: The provision
of a clear, solid comparative plan and coverage information in
plain English (routinely the case in FEHBP, and routinely
not the case in Medicare) is essential to an
effective system based on consumer choice and market
competition.

Section 202: Benefit Requirements.
Medicare Advantage (MA) plans would be required to cover all
existing Medicare benefits, except hospice coverage, plus drug
coverage under the terms of Part D, catastrophic and required
enhanced benefits. These would also include disease management,
chronic care, and preventive services. The Secretary of HHS could
exclude a plan that is "believed to attract a healthier
population." Moreover, the Secretary could not approve "any
enhanced medical benefit" that provided for any drug coverage
other than that provided for under Part D. The quality assurance
provision of current law would remain in force for MA plans.

Analysis: Comprehensive
standardization of the benefits packages has been a long-term
objective of those who favor government control over the American
health care system. If the government controls the benefits, and
the government then controls the financing, there is nothing left
of anything resembling a private sector market based on consumer
choice and competition. The object of serious Medicare reform
should be to expand consumer choice and competition in the program,
thus expanding the opportunities for individuals to secure high
quality medical services available in the private sector. Medicare
legislation should not become a vehicle for expanding Medicare's
regulatory control over private sector plans or inhibiting the
personal freedom of retirees to secure what options they think best
for themselves.

This is a highly prescriptive and
comprehensive benefits package; it is a direct statutory limitation
on the variety of plan offerings in the program. Medicare
fee-for-service covers specific medical services, treatments, and
procedures. The Senate language does not even appear to provide for
an actuarial equivalence for competing plans; so there is
little flexibility allowed in this language for benefit design
among health plans.

The provision that enables the Secretary, or
the Administrator of the CMC, to exclude a plan that is "believed
to attract a healthier population" is particularly troubling. The
Senate draft includes MSAs, but the government officials may
believe that MSAs attract a healthier population, or contribute to
adverse selection, and thus exclude them. This could also apply to
other new health care delivery options as well.

The proposed Secretarial limitation on
enhanced medical benefits and drugs, other than those specified, is
also incompatible with a new system alleged to be based on consumer
choice and free market competition. If a person wished to buy a
lower cost drug package, or a health plan with a leaner benefits
package, there should be no statutory obstacle to them doing so. In
an open, flexible market, the benefits and combinations of benefits
should be the choice of beneficiaries, not government
officials.

Needless to say, this provision is not
similar to the statutory language of FEHBP, where there is no
comprehensive standardization of benefits or services and
health plans of all types can offer a variety of benefit packages,
and different levels of benefits, as long as they offer the
statutorily required benefit categories such as
hospitalization and physicians services.

Analysis: This provision is
compatible with a Medicare reform based on consumer choice and
competition.

Section 203: Government Payments to Health
Plans. The new Medicare Advantage payment process is quite
complicated. The payment to plans under the new system would be
based on Medicare payment to plans under Medicare+Choice and the
payment for Medicare benefits and services under the Medicare fee
for service system. This is a crucial policy decision in the Senate
bill.

Under current law, Medicare+Choice, plans in a
payment area are get "an administered payment" for each enrollee,
which is the highest of either a specified minimum payment, a blend
of the local payment rate and the national rate, or a minimum
increase over the previous year's rate. (The minimum increase is 2
percent.) The Medicare+Choice payment rates are risk adjusted to
reflect variations in cost among enrollees in Medicare+Choice
programs and further adjusted to meet certain budget requirements.
In the case of Medicare+Choice payment, the Medicare reimbursement
to private plans, which has been out of sync with real changes in
the health insurance markets, has been one of the reasons why such
plans have been dropping out of the Medicare+Choice program.

In the case of Medicare fee for service,
hospital benefits are reimbursed according to a Prospective Payment
System (PPS) for services categorized under "diagnostic related
groups"; physicians' services are reimbursed according to the
Resource Based Relative Value Scale (RBRVS), which is a complex
formula for physician payment based on a social science measurement
of the "value" of different physicians' services, plus practice
expenses and other resource costs. Physicians' payments are capped
(price-controlled), and updated according to a government formula.
Medicare physician reimbursement has been a perennially
controversial, for it is a factor discouraging physicians and
specialists from seeing new Medicare patients.

Under the new Medicare payment system, it
appears from the Senate language that the government would make
three different monthly payments to health plans for three basic
sets of Medicare benefits: for Medicare hospitalization benefits
under Part A; for physicians services under Medicare Part B; and
for the new drug benefits, based on the terms and conditions of the
new Medicare Part D. As noted, private plans would be required
under the Senate language to offer all benefits and services under
Part A and B as well as the new drug benefits.

According to the draft outline: "Each year
the Secretary would calculate a benchmark amount for each MA
payment area for each month with respect to coverage of benefits
available under Medicare FFS. For plans participating on a county
basis, the benchmark would be the greater of 1/12 of the annual M+C
capitation rate for the payment area for the year or the local fee
for service rate. The local fee for service rate would be defined
as the amount of payment for a month in a MA payment are for
benefits, as well as associated claims processing costs, for an
individual who elects to receive benefits under the Medicare FFS
[fee-for-service] program and is not enrolled in an MA plan. In
calculating the local fee for service rate, adjustments would be
made to remove the costs for indirect medical and direct graduate
medical education."

In 2005, the Secretary would announce the
benchmark amounts for each Medicare Advantage "area" and the
factors to be included in the new "comprehensive risk adjustment
methodology" to be applied to payments to private plans.

In 2006, the payment would be based on bids of
competing plans. The government would calculate the amount based on
the weighted average of the benchmark amounts for benefits in the
Medicare FFS plan. The benchmark amount would be adjusted for risk,
the risk adjusters for prescription drug coverage, and health and
other demographic features.

In determining payments to each plan, the
Secretary would determine the difference between the weighted
average in the area and the bids of each plan. If a plan bid equals
or exceeded the weighted average, the plans would get the benchmark
amount. If a plan bids below the weighted area benchmark, the plan
would get the benchmark amount, minus 25 percent of the difference
between the bid and the benchmark amount.

Analysis: The benchmark for
payment private plans is to be based on the weighted average of the
Medicare FFS benefits in an area. FFS benefits and services
are price-controlled, and subject to Medicare complex fee schedules
and payment caps. They are not market prices. This could pose a
problem: it could discourage the participation of private plans.
The Senate bill language could thus replicate the failure of
administrative payment that has undermined the Medicare+Choice
program.

Payment to private plans in the FEHBP is very
different. Under the FEHBP statute, the government pays 72 percent
of the average premium of participating plans (weighted by the
number of enrollees) in the program. The government payment is
capped, according to a formula, at a dollar amount for family and
single coverage, and the government contribution is limited to no
more than 75 percent of the premium cost of any particular plan.
While there are clearly deficiencies in the FEHBP payment system,
(for example, the current 75 percent cap means that no enrollee
will ever be able to pocket the entire savings for picking a less
expensive plan), the value of the FEHBP payment to plans rests in
the fact that it is a payment based on real market conditions, an
inherently attractive feature of the program.

An even better policy is embodied in the 1980
legislative proposal offered by Representative Richard Gephardt
(D-MO): The National Health Reform Act of 1980. Rep. Gephardt
proposed comprehensive Medicare reform based on a competitive
system of private health plans. For Medicare beneficiaries who
chose private plan options, they would have gotten a government
contribution to the plan in an amount equal to the average cost of
plans purchased by the Medicare beneficiaries. While the private
plans would have been required to provide benefits greater in value
than the traditional Medicare program, beneficiaries would have
been able to choose from among a wide variety of premium options.
Under the original Gephardt proposal, if a Medicare beneficiary
chose a plan whose premium was less than the government's
contribution, they would have been able to keep the difference as a
tax refund.

In the Senate bill, there is a proposal to
establish a comprehensive risk adjustment mechanism. In the FEHBP,
of course, there is no risk adjustment mechanism at all -- a
weakness in the current program. Even so the program, for
structural reasons and reasons related to the contribution system,
is not burdened by serious or destabilizing adverse selection.

Nonetheless, instead of trying to create a
risk-adjustment mechanism to deal with adverse selection among
plans, the Senate bill drafters might consider the establishment of
a mandatory reinsurance pool, where plans cede risks associated
with particularly high-cost enrollees, pay a premium into the pool
and get an offset every year if they incur enrollments with higher
than expected risks. This might be preferable than trying to
adjustment payments up front.

In any case, if the payment is not based on
real market forces, the danger is that it will be insufficient to
attract significant plan participation.

Section 204: Information Required from
Plans. The Senate bill provides that plans must give HHS the
intent to cover a service area, the type of plan, information on
coordinated care, enrollment capacity, health status of enrolled
individuals, and "other information" required by the Secretary.

Analysis: This is a significant
amount of required information. As a point of comparison, there is
no similar statutory requirement in the FEHBP, though health plans
are required by OPM to keep records of information.

Section 204 Benefit Controls. If the
plan bid were lower than the benchmark, the secretary would require
the plan to provide additional benefits, or lower the deductible or
decrease the maximum on out-of-pocket expenses. However, plans
would not be allowed to offer additional benefits for the
coverage of a prescription drug other than that provided under
Medicare Part D. If the plan bid was higher than the benchmark,
the plan could charge a beneficiary premium.

Analysis: This is simply
government control of the benefit levels and financing offered by
private plans. Plans should not be limited in what they can add, in
terms of drug benefits, or other kinds of legal medical services,
and consumers should not be forbidden from buying such benefits and
services with their own money. This is incompatible with Medicare
reform based on consumer choice and free market competition.

Section 205: Special Drug Rules. Plans
would be required to offer drug coverage that met coverage
requirements under Medicare Part D. A plan could offer more
generous coverage if it also offered the basic coverage in the same
area.

Analysis: This is a government
standardization of prescription drug coverage in private health
plans, and it is incompatible with Medicare reform based on
consumer choice and competition.

Section 206: Special Rules for Employer
Sponsored Plans. Employers can sponsor a MA plan or pay
premiums for retirees who enroll in an MA plan. The plans must meet
the standardized benefits requirements of the MA system and the
Secretary for HHS may waive rules that hinder union or employers
from offering MA plans.

Analysis: The idea of enlisting
employers and unions and their health plans in Medicare reform has
been long championed by Heritage analysts and others. If a person
is happy with their health plan they should be able simply to take
that plan into retirement with them as their primary coverage, and
get a premium support or government payment for to offset its cost.
The comprehensive benefit standardization in the Senate bill
basically undermines this option, and is therefore incompatible
with Medicare reform based on consumer choice. The proposed
Secretarial waiver to allow union or employer plans to participate
is only necessary only because the proposed benefit standardization
is unnecessarily restrictive.

Section 207: Administration of Medicare
Advantage System. The Medicare+Choice Plans created under
Medicare Part C and the new Medicare Advantage Plans are to be
administered by an Administrator of the Center for Medicare Choices
within HHS. This ends the administration of CMS over private health
plans. The new agency head could make determination that a plan had
failed to meet its contractual obligation.

Analysis: This is compatible
with the majority proposal of the National Bipartisan Commission on
The Future of Medicare (the Breaux-Thomas Commission) and others to
establish a separate agency administering a consumer-based system.
The proposal is to leave CMS in charge of the administration of the
traditional Medicare program.

Section 208: Conforming Amendments. The
language says that a Medicare plan would "not be allowed to charge"
a consumer any amount in excess of the Medicare Advantage monthly
beneficiary obligation for "qualified prescription drug coverage,"
or provide coverage that is not "qualified prescription drug
coverage," and offer prescription drug coverage but not make the
standardized drug coverage available, or provide coverage "for
drugs other than that relating to prescription drugs covered under
Part D as an enhanced or additional benefit." Section 209 makes the
effective date of this provision January 1, 2006.

Analysis: This provision would
have the government specify drug benefits levels in a system of
competing private health plans. This is incompatible with a
Medicare reform based on consumer choice and market competition.
Health plans should have the freedom and ability to devise flexible
drug coverage options that meet the needs of their customers.

Section 211: The Establishment of the
Preferred Provider Option. Beginning in January 2006, the
authors of the Senate bill would create a new system of PPOs in ten
regions of the country, which would have a network of providers
that would contract for services under existing Medicare Parts A
and B. The regions would be charted in such a way that states would
be left whole and entire. The PPO would serve the entire region.
The Secretary (or the CMC Administrator) could exclude PPOs that
are "believed to attract a population that is healthier than the
average population of the region serviced by the plan."

In 2006 and 2007, PPOs would not be "initially
responsible" for the risk of offering medical benefits. The
language sets forth a formula for limiting the risks of PPOs,
though PPO's would be at full risk for all "enhanced medical
benefits."

Beginning in 2006, the government would
calculate a benchmark payment for each region of the country,
"equal to the average of each benchmark for each MA payment area
within the region," weighted annually by the number of
beneficiaries in the payment area. The government would adjust
these payment rates by the "comprehensive risk adjustment factor"
and the spending variation within the region.

Then the plans would submit bids to the
Secretary of HHS (actually, the CMC Administrator), with
assumptions about the "number of enrollees." The language of the
proposal then details the steps the Secretary makes in arriving at
payment for PPOs: "The Secretary would adjust each plan bid
based on the plans' assumptions about enrollment. The Secretary
would calculate a regional benchmark amount for each plan equal to
the regional benchmark adjusted for the number of enrollees assumed
in the plan bid. The Secretary would determine the difference
between each adjusted plan bid and the plan's regional benchmark
amount to determine the payment amount, additional of benefits
required, and the MA (Medicare Advantage) monthly basic beneficiary
premium."

Under the Senate bill, for any plan bid that
equals or exceeds the benchmark, the plan would get the plan
benchmark amount. For any plan below the plan benchmark amount, the
plan would get the benchmark amount minus 25 percent of the
difference between the plan bid and the plan benchmark.

The Senate bill the provides that, "The
Secretary shall limit the number of plans in a region to the three
lowest cost credible plans that meet or exceed the quality or
minimum standards."

Analysis: Not only is this a
complicated payment system, but also the deliberate restriction of
PPO choice to the three cheapest plans is incompatible with
Medicare reform based on consumer choice and competition.

The Senate bill's creation of a
government-sponsored oligopoly of regionally based PPO plans is
short sighted. In the face of a rising demand for medical services
among a rapidly aging population, Medicare reform language should
encourage diversity and an enlargement of options.

If such plans meet basic requirements, or
"minimal reasonable requirements" (as specified, for example, in
the FEHBP statute), the government would not pick "winners and
losers"; consumers would pick winners and losers. In a normal
competitive market, there is free entry as well as free exit of
plans, and consumers can pick and choose the kinds of plans and
options they want, whether they are lower cost plans or higher cost
plans. This obviously is not the case under this language. Needless
to say, there is no similar PPO restriction in the FEHBP.
Furthermore, all plans participating in the FEHBP assume the risk,
not the taxpayers.

TITLE III- THE CENTER FOR MEDICARE
CHOICES

Section 301: The Establishment of a Center
for Medicare Choices. The language of the bill provides for the
establishment of the Center within HHS to administer the new
Medicare Parts C and D. The Center would be governed by an
Administrator, appointed by the President and confirmed by the
Senate, for a period of five years. The draft outline also provides
for an Office of Beneficiary Assistance within the CMC, and an
Ombudsman within the CMC to handle beneficiary grievances, requests
for information, and enrollment related problems. The provision
sets up a Medicare Competitive Policy Advisory Board within CMC to
advise, consult with and make recommendations to the Administrator
regarding the "administration and payment policies" of parts C and
D.

The Administrator would be authorized to issue
"such rules and regulations as the Administrator determined
necessary and appropriate to carry out the functions of the CMC,
subject to the Administrative Procedures Act."

The duties of the Administrator include the
requirement to "negotiate, enter into and enforce contracts with
Medicare Advantage plans ands with eligible entities for Medicare
prescription drug plans. The Administrator would be required to
carry out any duty provided for under part C or D of Medicare
including demonstration programs under Part C or D."

The language of the draft further specifies
that, "The Administrator of the agency, to the extent
possible, would not be able to interfere in any way with
negotiations between eligible entities, Medicare Advantage
organizations, hospitals, physicians or other entities or
individuals furnishing items and services under this title
(including contractors for such items and services), and drug
manufacturers, wholesalers, or other suppliers of covered
drugs."

Analysis: It would appear that
the Administrator would fulfill a role broadly similar to that of
the Director of the Office of Personnel Management in the
administration of the FEHBP, in which the OPM Director exercises
broad contract authority in the annual negotiation with competing
health plans in that program.

There are, however, some crucial differences
in this Senate Finance Committee language and the statutory
language that governs the FEHBP in the regulations of health plans.
In the Senate language, the Administrator is authorized to issue
such regulations as the Administrator deems necessary and
appropriate to fulfill the responsibilities under Medicare Part C
and D.

In the FEHBP, OPM, "may prescribe regulations
necessary to carry out this chapter" (Section 8913a of Chapter 89
of Title V), but the chapter focuses on a few items, such as
consumer protection, non-discrimination, and fiscal solvency. The
authority also extends to regulations governing the enrollment of
eligible beneficiaries, the beginning and ending dates of coverage
and the continuation of coverage (Section 8913b) and Section
8913c). Altogether, there are just 18 sections of Chapter 89, Title
V, and they range from OPM's contracting authority, to provision of
information to individuals eligible to enroll and the management of
the Employees Health Benefits Fund.

In the FEHBP, OPM is authorized under Section
8902 of Title V of the US Code to "prescribe reasonable minimum
standards for health benefits plans… and for carriers
offering the plans." The minimum reasonable standards apply to
contracting with different types of plans, and providing for
different levels of benefits. (Sections 8903 and 8903a). So, at
least in terms of dealing with health plans, the CMC Administrator,
to all appearances, has a broader regulatory reach than OPM.

The Senate language appears to put a barrier
to the Administrator's interference with contracts between plans
and with doctors and hospitals and other entities, but then adds
the foreboding caveat: To the extent possible. But, the
possibilities of the Administrator's power are up to the
Administrator, and thus only limited by the Administrator's
possible enthusiasm to micro-manage private plans.

In a competitive system, like the FEHBP, for
example, the government does not intrude into private contractual
relations between doctors and hospitals and health plans or other
entities. In the case of wrongdoing, criminal behavior or cases of
medical malpractice OPM is authorized to bar physicians from the
program. (Section 8902a, Chapter 89, Title V).

Moreover, in a competitive system, like the
FEHBP, there is no centralized imposition of fee schedules (like
the Medicare DRGs or the RBRVS), premium caps, price controls,
formularies for drugs, or any imposition of physician or medical
practice guidelines on doctors or other medical professionals. One
of the benefits of a consumer-driven system is to enable patients,
if they wish to, to avoid that sort of intervention. This language,
however, does not appear to preclude such interventions.